IFUGAO STATE UNIVERSITY

COLLEGE OF BUSINESS AND MANAGEMENT

1st Term; Academic Year 2023-2024

PERSONAL FINANCE AND INVESTMENT MANAGEMENT

CHAPTER V: INTRODUCTION TO INVESTMENTS

 Definition and Types of Investments

 Participants in the Investment Process
 Types of Investors
 Economic Importance of Investing
 Rewards from Investing
 Steps in Investing
 Characteristics of Investments
 Psychological Aspects of Investing

a. Definition and Types of Investments

Investments refer to any form of assets in which funds are allocated with an expectation of
a positive return or increasing its value. This would mean that an individual who has PHP 1.5
Million may invest in real state (buying a lot) with an expectation that he can sell the lot in the
amount of PHP 2 Million or more. Selling it at a higher price would indicate a positive value.
Investment may also be defined as the assets acquired to realize income and/or profits.

One of the reasons why people save is for financial security. They set aside a portion of their
disposable income and place in an investment for a return.

There are several reasons why people would invest their money. Their investment objectives
may include a down payment for a house, a new car, college education for their children,
vacation and trip, retirement as well as supporting their life expenses during their retirement.

Among the objectives mentioned, a more important benefit for a person is to invest today to
guarantee a more comfortable and financially secured retirement.

Investing is a more active approach to wealth accumulation which involves risk. Before a
person should invest, there are several considerations to note which include the
following:

1. Liquidity. This refers to how soon will a person need the money invested or placed
in a savings account. Also, he should be able to determine the amount of his
expenses and emergencies on a short-term basis.
2. Returns. This would mean the earnings or appreciation of the principal value
invested. Sources of returns may be in the form of dividends, interest, or income from
rent. Capital appreciation or capital gain signifies growth in the investment.
3. Tax Implications. This refers to determining the growth of investment availing tax-
advantaged savings.
4. Risk. This refers to the willingness of the person to take the uncertain consequences.
Can a person sleep well at night when the value or price of the investment goes
down? Considering the risk-return trade-off, a person is willing to take a risky
investment as long as there is an additional compensation on that risky investment.
The following are examples of risks encountered in investing:
 Interest Rate Risk. This refers to the changes in interest rate level. Usually,
the fixed income investment such as bonds or mutual funds is affected by this
type of risks. An investment with a longer-term would have a higher interest
rate as compared to short-term investment because of the risk it bears.
  Business Risk. A business may experience unforeseen circumstances which
could adversely affect the value of person’s investment. This risk may be
experienced by one company or the industry which may not be encountered
by other companies or industries.
 Credit Risk or Default Risk. This refers to the possibility of the issuer (e.g.
corporation or the government) to pay the obligation such as interest and
principal for bonds or suspension of dividend payments for stocks at the time
promised.
 Market Risk. This arises from the ups and downs and sentiments of the
markets, which may affect the prices or value of bonds and stocks.
 Purchasing Power/Inflation Risk. Investment is affected when the financial
return losses its purchasing power due to a general increase in the price of
goods and services. To remedy this situation the expected return must be
higher than the inflation rate.
 Political Risk. Investors are affected when the political and socio-economic
condition of the country changes and the sentiments of the market is affected
which includes business profits and investment return.

Types of Investments

Investors may have different preferences in investing depending on the type of risk tolerance
they may have. Investments may be classified according to the following classifications

1. Securities and Property

Securities are investments that represent indebtedness or ownership of a business or
other assets or having the legal right to buy or sell an ownership interest in a
business or assets. An example of a most common debt security is a bond while
examples of common ownership securities are stocks, options and other fixed
income securities.
Property are investments in real or tangible properties which includes residential
homes, land, buildings and those that are permanently affixed to the land while
examples of tangible personal properties are gold, antiques, jewelries and other low-
liquid assets.
2. Direct and Indirect
If an investor directly acquires a claim on a security or tangible property for the
purpose of earning a return or preserving its value, the investor has made a direct
investment. An example of direct investment is when you buy a bond, stock or a
parcel of land which you intend to sell at a price higher than the acquisition price.
However, if you buy a security or a tangible property through a group of securities or
properties, you have made an indirect investment. An example of indirect investment
is when you acquire a security issued by a mutual fund company which entitles you
to own a claim on a fraction of the entire portfolio rather than on a security of a single
firm.
3. Debt, Equity or Derivative Securities
Debt securities refer to funds borrowed in exchange for an interest income to be
received regularly for a specific period of time and the promised of repayment of the
amount borrowed at a given future date. An example of this debt security is when you
acquire a bond from a company that issued it, which means that this company is
indebted to you and agrees to pay you a fixed income in the form of interests plus the
repayment of the original amount at a given specific future date.
Equities signify ownership interest in a specific business or property. An example of
equity investment is buying a stock of a particular corporation. Being a stockholder,
you are considered as a part owner of that particular business.
 Derivative securities are structured to display similar characteristics to those of
underlying security or asset. The basis of the value of these derivative securities are
from the price behavior of the underlying real or financial assets. Examples of
derivative securities are options and futures.
4. Low and High Risk Investments
An investment with greater range of possible value or returns is considered to be
more risky. An example of low-risk investment is depositing your money in a savings
account that with a two percent interest rate. It is considered to be low risk because
there is greater possibility that the bank will give the depositor the said interest rate
as compared to putting your money in a business that will give a return or profit
greater than the two percent interest rate. Because of the economic crisis, there is
possibility that the business will not be able to generate the forecasted profit which
may be attributable to some factors.
5. Short and Long-term Investments
Investments may be classified according to the life of the investment. Short-term
securities are investments that on the average nature within a period of one year or
less. An example of short-terms securities are treasury bills, deposit accounts,
certificate of deposits, short-term commercial papers and others.
Long-term investments are investments with maturities longer than one year or those
that do not have any maturity date like common stocks (there is no specific date
when to sell the common stocks).
6. Domestic and Foreign Investments
Domestic investments refer to the securities or properties of home-based companies.
Examples of domestic investments are stocks or real estate properties owned by
home-based companies. Foreign investments include securities or properties of
foreign-based companies like acquiring stocks of a foreign-based company.

b. Participants in the Investment Process

1. Government (National or Local)

The government is considered to be one of the major participants in the investment
process because they require a huge amount of funds to support their capital
expenditure. These capital expenditures are long-term projects which include
construction of public facilities like schools, hospitals, bridges and highways. On the
other hand, the government would have to secure funds for their operating needs
such defense, education, public works and the others. When expenditures of
government are greater than its revenue, the government resorts to borrowings by
issuing debt securities.
2. Business
Regardless of the type and size of the business, they require large amount of money
to fund its operation. The financial needs of the business may be long or short-term.
Normally a business requires funds on a long-term basis to expand, produce new
product, and acquire new equipment and other projects. Still, business may require
additional funds on a short-term basis to finance inventory requirements, accounts
receivable, and other operating costs.
Business is also a supplier of funds by investing their idle cash into some long-term
investments like buying stocks, bonds, and other assets of other companies.
3. Individuals
Individuals are both considered as borrowers or lenders of funds. Most individual
borrow money from financial institutions to finance acquisition of real estate or other
tangible properties. However, these individuals are considered as supplier of funds
because the place their savings accounts, mutual funds, buy debt and equity
instruments.
c. Types of Investors

1. Individual Investor
Individual investors manage their personal funds to achieve their financial goals.
These individual investors buy securities and properties to earn from their idle funds
and eventually could be a source of their income for the retirement as well as for the
security of their love ones.
2. Institutional Investor
Institutional investor refer to investment professional who are paid manage the funds
of other people. They trade large volume of securities on behalf of others.
Institutional investors have more sophisticated investment knowledge and techniques
as compared to individual investors.

d. Economic Importance of Investing

The growth of a country’s economy depends on the availability of funds. If any of the above-
mentioned participants in the investment process would not actively invest their idle cash,
there is no ready available funds that can be borrowed by any of them to expand their
business, produce new product line and acquire new equipment, etc

The net effect of a decreased in investment would contribute to the less active economic
venture.

e. Rewards from Investing

In order for the investment process to succeed, investors or providers of funds should be
rewarded or earn a return. This reward or return is in the form of current income and price
appreciation or capital gain.

Current income refers to the return that an investor receives on a regular basis such as
interest from bond or savings account, rental income from the building leased and others.

Price or value appreciation is the increased in the original price of a security or asset from
the time of purchase to the time of sale of the asset. (Selling Price – Acquisition Price)

Basically, the rewards or returns of investments would depend on the type of investment, the
length of time involves and the risks established in the transaction.

f. Steps in Investing

Before a person starts thinking of investing, he should consider the following steps:

Step 1: Meeting the prerequisite of investing.

A person before starting to buy securities or properties, he must be able to set aside
adequate funds for his basic needs to be incurred for his daily sustenance before investing.

Also the individuals need to establish certain retirement goals prior to setting specific
investment goals.

Step 2: Establishing Investment Goals

After satisfying step 1, the person may start creating an investment goal taking into
considerations the timing, form, and risk associated a desired return. For example, at the
age of 50, I would like to accumulate about PhP 3 Million for my retirement in addition to the
monthly pension that I will be receiving when I reach the age of 60 as a private employee.
The goal established must be realistic; otherwise, it is useless setting up a goal that cannot
be accomplished in the future.
In order for the person to realize the desired amount, the person must have adequate funds
available for investment and must assume to attain a particular rate of return to achieve the
said goal.

Step 3: Adopting an Investment

This refers to the written document describing how you will invest funds. You can develop a
series of supporting investment goals for each long-term goal. For each goal, you specify the
target date for achieving it, up to the tolerable risk. The more specific you are in your
statement of your goals, the easier it will be establish a strategic plan consistent to your
goals.

Step 4: Evaluating Investment Vehicles

A person who wishes to invest must learn how to evaluate investment vehicles. Before
selecting the type of investment to take, he must be able to assess the potential return of
each investment alternative as well as the risk offered by each vehicle.

Step 5: Selecting Suitable Investments

Another important aspect in the investment process is to select the specific investing
vehicles which could affect significantly the achievement of the investment goal. In selecting
suitable investments, it should consider the return, the risk involved and tax considerations.

It is possible that the investment gives a very high return but there is a great risk in receiving
the estimated cash flow. Likewise, the selected investment vehicle may have a very high
taxation consideration.

Step 6: Constructing a Diversified Portfolio

An investment portfolio is a collection of different types of investment vehicle. Diversification

would mean having a different type of investment vehicle in the portfolio. This could pertain
to the old adage “Do not put all your eggs in one basket”.

To construct a diversified portfolio of an investment and meet the established investment

goals, one you should be able to choose the investments that are not related to the current
investment. In short, they must be negatively correlated in order to reduce the risks involved.

Step 7: Managing the Portfolio

Managing the portfolio would mean, trying to evaluate the actual behavior of the investment
vehicles against it estimated behavior. If an investment vehicle does not perform according
to the expected performance, you can make necessary correction to the extent of removing
it from the portfolio.

g. Characteristics of Investment

1. Return is the key factor in determining the attractiveness of the investment. This may
come in the form of an income and appreciation. Income would include the dividends
from stocks, interest from fixed income investment, and rent income from real
properties being leased. Appreciation and capital gain is incurred when selling price
is greater than the acquisition price of the particular investment.
2. Risk refers to the possibility of not being able to attain the desired outcome. In
investment, there two expectations about risk. One is a downside risk where return is
less than anticipated return. The other expectation is upside potentials which refer to
the return which will exceed expectations.
 3. Liquidity relates to the ease of extracting the original commitment from an
investment. This means that the investment can be easily converted to cash.
4. Marketability refers to the ease or difficulty of buying or selling the asset at its
market value. This characteristic of the investment is very important particularly in the
composition of short-term investment. An example of this is treasury bills are more
marketable or could be easily sold as compared to commercial papers because there
is lesser risk involved in the treasury bills as compared to commercial papers.
5. Investment Effort would refer to selecting and managing of some types of portfolios
require little or no special knowledge, facilities or time commitment.
6. Minimum Investment Size refers to the amount of money required to buy a
particular investment. Some investment may require a much larger minimum
commitment or amount of money.
7. Ethical and Moral Appeal. Some investments may have different ethical and moral
appeal to certain group of investors. This would mean that some investors put their
money in investments that they appreciate because of the product does not harm the
community; it conforms to the established goals of the company, does not have
misleading advertisements and others.

h. Psychological Aspects of Investing

This would refer to the behavior of the investor particularly in buying the investments that it
was not done impulsively. It is possible that the investors buy a particular stock because he
was influenced by another person or because it was a fad. In buying investments it is
important to study the type of investment that we are buying, the company, the industry it
belongs and the economic indicators that affect the investment. Also, it is possible to study
the trend of price of the investment by looking at the historical prices or analyzing behavior of
market.